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Looking Back On The Eckhardt Amendment

Tuesday, March 19th, 2013

Yesterday’s post (here) highlighted the FCPA’s first mega-enforcement action involving multiple actors.

The story remained open as to George McLean (Vice President of Solar Turbines International (“Solar”), a division of International Harvester Company), and Luis Uriarte (the Latin American Regional Manager of Solar).

As noted in the prior post, soon after McLean and Uriarte (and several others) were indicted in October 1982, in November 1982 the DOJ also filed a criminal information against International Harvester (see here). The information was based on the same core set of allegations as in the October 1982 indictment and was based on the conduct of its employees McLean and Uriarte. International Harvester pleaded guilty to conspiracy to violate the FCPA (see here) and was ordered to pay a $10,000 fine and agreed to also pay $40,000 civil cost reimbursement. (Notice the italics).

McLean and Uriarte filed a motion to dismiss the indictment principally based on the so-called Eckhardt amendment that was then part of the FCPA. In June 1983, Judge George Cire (S.D. Tex.) granted the motion to dismiss the substantive FCPA charges against them, but not the conspiracy charge. The DOJ appealed the dismissal which lead to a Fifth Circuit opinion. Before summarizing Judge Cire’s decision, as well as the Fifth Circuit’s decision, this post provides background information on the so-called Eckhardt amendment.

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The Eckhardt amendment was named after Representative Robert Eckhardt (D-Tex). If you read my detailed history of the FCPA, “The Story of the Foreign Corrupt Practices Act,” you will learn that Eckhardt was a leader in the House as to what would become the FCPA. My article provided a detailed overview of the FCPA legislative history, yet at the same time to keep the article at a publishable limit, omitted certain side issues also found in the FCPA’s extensive legislative history.

One side issue that developed towards the later part of the FCPA’s legislative history as the basic contours of the law began to take shape, and an issue of great concern to Representative Eckhardt, was that individual corporate actors might be put at a disadvantage in defending themselves in an FCPA enforcement action.

Representative Eckhardt stated in an April 1977 hearing, in pertinent part, as follows.

“I don’t have any compunctions against making acts of foreign bribery illegal for the corporation. [...] [T]he [corporate] defendant would always be able to marshal what evidence there was to contradict any contention that the company had anything to do with the bribery. With respect to that necessary element of the case without which a conviction could not be had, the defendant would be peculiarly in control of the evidence, both overseas evidence and domestic evidence. But this is not so with respect to the individual who is an agent of such issuer and who is being accused of an act overseas where the totality of the proof would be from activities overseas. Indeed, the corporations interest might even be in conflict with that of the agent. The corporation might desire to have Joe Bloke found to have intentionally engaged in bribery and to have been the sole moving agent, that is, the company never agreed to it and the quicker they can convict Joe Bloke, the better off the company is. It is relieved of responsibility and it has a sacrificial lamb in Rome and everybody forgets about the activity.”

[...]

“I don’t find any difficulty whatsoever with the corporation’s position as a defendant because indeed it has a very inside road to testimony and information. [...] [I]t seems to me that there is a vast difference between the position of the individual defendant accused of having violated the act and the corporate defendant. Besides, the individual defendant can be clapped in jail and the corporation can’t be clapped in jail.”

In September 1977, Representative Eckhardt testified before a House committee and likewise stated, in pertinent part, regarding H.R. 3815 (a bill he introduced, which in compromise with S. 305, ultimately became the FCPA).

“[W]e were so concerned about the individual penalty as a means of making a scapegoat of an individual that we provided in our bill that unless the corporation were found to be guilty there could not be an individual penalty at all.”

In short, the FCPA originally contained the following introductory language as to the penalty provisions applicable to employes or agents of issuers of domestic concerns “whenever an [issuer or domestic concern] is found to have violated [the FCPA's anti-bribery provisions] …”.

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Back to McLean and Uriarte’s challenge.

In granting the motion to dismiss the substantive FCPA charges against them, Judge Cire noted that the defendants’ employer, International Harvester, pleaded guilty to conspiracy and not to a substantive FCPA offense. Judge Cire reasoned that “conspiracy and the related substantive offense which is the object of the conspiracy are separate and distinct crimes.”

Accordingly, Judge Cire concluded as follows. “Since International Harvester plead guilty to conspiracy and not to a substantive FCPA violation, it has not been found to have violated the FCPA. The Eckhardt amendment protects employees like McLean and Uriarte from prosecution under the FCPA when their employer has not been found to have violated the FCPA.” (See here for Judge Cire’s Memorandum and Order).

The DOJ appealed Judge Cire’s order and presented three arguments on appeal: (1) that the FCPA does not require the employer be convicted of an FCPA violation, only that it be established in the employee’s trial that the employer violated the FCPA; (2) that McLean, as an individual, may be charged with aiding and abetting FCPA violations; and (3) that International Harvester’s conviction of conspiracy was sufficient.

The Fifth Circuit began its decision (here) as follows.

“We are presented for the first time with the question of whether the FCPA permits the prosecution of an employee for a substantive offense under the Act if his employer has not and cannot be convicted of similarly violating the FCPA.”

The Fifth Circuit began its decision as follows.

“Our task in interpreting the FCPA ‘is to construe the language so as to give effect to the intent of Congress. To do so, we look primarily to the language of the statute and secondarily to its legislative history, which includes the ‘purpose the original enactment served, the discussion of statutory meaning in committee reports, the effect of amendments-whether accepted or rejected-and the remarks in debate preceding passage.”

[See this recent post highlighting the importance of the FCPA's legislative history]

The Fifth Circuit then reviewed the “found to have violated” language of the Eckhardt amendment and stated as follows.

“Hearings were conducted on the precurser to the final version of the Eckhardt Amendment in April of 1977 by the subcommittee of the House Interstate and Foreign Commerce Committee. The subcommittee examined two proposed bills: (1) H.R. 3815, introduced by Congressman Bob Eckhardt, which imposed as a prerequisite to the conviction of an employee a showing of violation of the Act by the issuer or domestic concern, and (2) H.R. 1602 which had no such requirement. At the hearing, Congressman Eckhardt, the subcommittee chairman, in discussing H.R. 3815 [... stated as follows].

“Indeed, the corporations [sic] interest might even be in conflict with that of the agent. The corporation might desire to have Joe Bloke found to have intentionally engaged in bribery and to have been the sole moving agent, that is, the company never agreed to it and the quicker they can convict Joe Bloke, the better off the company is. It is relieved of responsibility and it has a sacrificial lamb in Rome and everybody forgets about the activity.”

The Fifth Circuit then stated as follows.

“Congressman Eckhardt pointed out the dependence of the agent on the corporation for an adequate defense since the corporation, due to its superior resources, would be in a much better position than the employer to defend against accusations of wrongdoing in a foreign country. He articulated concern over legislation that would require the agent alone to bear the burden of refuting allegations of FCPA violations. He was also troubled about giving the uncharged corporate employer incentive to both disavow knowledge of the agent’s activity and to let the agent bear all responsibility for the wrongdoing. This problem was avoided [...] because what would become the Eckhardt Amendment ‘would require the government … to prove in the first instance that the issuer had violated the section, because that is the condition precedent to the holding of any agent responsible.”

After reviewing other aspects of the FCPA’s legislative history, the Fifth Circuit concluded that “both the language of the Act and its legislative history reveal a clear intent to impose criminal sanctions against the employee who acts at the behest of and for the benefit of his employer only where his employer has been convicted of similar FCPA violations.”

The Fifth Circuit then stated as follows.

“We hold that in order to convict an employee under the FCPA for acts committed for the benefit of his employer, the government must first convict the employer. Because the government failed to convict Harvester and under the plea agreement will be unable to indict Harvester and try it with McLean, the Act bars McLean’s prosecution.”

In so holding, the court observed that “it is well-settled that a conspiracy to commit an offense and the commission of a substantive offense are separate and distinct crimes.”

Uriarte was subsequently charged in a one-count superseding information and pleaded guilty to “accessory after the fact” in violation of 18 USC 3. He was placed on probation for one year. (See here).

As for McLean, contrary to what the FCPA Blog stated in this prior post, the Fifth Circuit’s decision did not end the DOJ’s case against McLean in that the decision only addressed the substantive FCPA charges against him that were dismissed by the trial court. The Fifth Circuit decision did not address the conspiracy charge against McLean.

As to the conspiracy charge, McLean proceeded to trial and was found not guilty by the jury.

*****

Stung by its McLean defeat, the DOJ sought to repeal the Eckhardt Amendment. In a September 1986 FCPA reform hearing in the Senate, John Keeney (Deputy Assistant Attorney General, Criminal Division) submitted a written statement, which read in pertinent part, as follows.

“The Department also wishes to highlight a serious law enforcement problem in both the existing law and in [a Senate bill to amend the FCPA], with respect to the prohibition against convicting an employee (and, in the present FCPA, an agent) of an issuer or domestic concern unless the domestic concern itself is ‘found to have violated’ the Act. The purpose of this provision, known in the present FCPA as the Eckhardt Amendment, was to prevent a company from labeling an employee as a renegade, thereby making him a scapegoat for the company’s criminal acts, and forcing him to bear alone the full economic burden of defending the criminal charges as well as the potential criminal sanctions. This goal, unfortunately, has not been met. There is nothing to prevent a company from pleading guilty to a FCPA violation thereby forcing the employee or agent to defend by himself. Situations similar to this have occurred in the cases brought thus far.”

“While the Eckhardt provision falls short of fulfilling its purpose, it also makes it more difficult to prosecute certain classes of individuals regardless of the quantum of evidence as to their guilt or that of their employers. In the only reported opinion on this issue, an appellate court construed Eckhardt to mean that a company must be convicted of a FCPA violation rather than merely be ‘found to have violated’ the act.”

“In that case, a company entered a pre-indictment guilty plea to conspiracy to violate the FCPA rather than to a substantive violation of the Act. The conspiracy plea was permitted because of the serious financial condition of the company and the real possibility that the imposition of a substantial fine would force it into bankruptcy. Two company employees were indicted for multiple FCPA violations as well as for conspiracy to violate the FCPA. The government offered to present proof beyond a reasonable doubt that the company had violated the FCPA and suggested that the Court instruct the jury to make the required Eckhardt finding prior to considering the guilt or innocence of the employees. The Court rejected these alternatives and dismissed the FCPA charges. In our view, this construction of the statute does not comport with the intention of Congress in enacting the Eckhardt language.”

“A similar problem exists where a company, over the objection of the United States, enters a plea of nolo contendere to FCPA violations. In that situation, a court could enter a judgment of conviction against the company for FCPA violations without necessarily making a finding as to guilt for purposes of the statute. Arguably, the United States might be prevented from prosecuting an employee or an agent of that company following such a conviction. Such an argument has recently been made by a fugitive defendant who, as agent for a domestic concern, acted as the conduit for transmitting in excess of 10 million dollars in bribes to two foreign officials on behalf of the company which pleaded no contest to 48 FCPA charges. Given the current state of the law, the eventual resolution of this issue is not completely free from doubt. What is clear is that there is no justification for allowing conduct of this sort to go unpunished.”

“Should the Subcommittee wish to retain the language of Eckhardt, the Department would suggest that it clarify what is meant by “found to have violated.” Alternatively, the Subcommittee might wish to substitute some other language which more clearly sets out the intent of Congress. If the Subcommittee wishes to insure that the goals of Eckhardt are met, we suggest adding language requiring a company to indemnify an employee’s attorney’s fees unless it can be shown that the employee was clearly was operating as a renegade or without the company’s knowledge. The Department is willing to work with the Subcommittee to clarify the Eckhardt provisions.”

A relevant House Conference Report in April 1987 (Rep. 100-576) as to a bill to amend the FCPA stated, in pertinent part, as follows.

“Anti-bribery Provision – House Repeal of Eckhardt Amendment

House bill. The House bill repealed the so-called Eckhardt amendment to the FCPA by deleting the lead-in clause of present law, which reads “whenever an issuer/domestic concern is found to have violated …”. The deleted language had the effect of providing that employees or agents could not be prosecuted for FCPA violations unless the domestic concern or issuer, whichever the case may be, had been found to have violated the Act.

Senate amendment. The Senate amendment contained no comparable provision.

Conference agreement. The Senate receded to the House.

When the FCPA was finally amended in 1988, among its changes, was repeal of the so-called Eckhardt amendment.

Puzzled By Straub And Steffen

Wednesday, March 13th, 2013

Prior posts here and here summarized the recent judicial decisions in SEC v. Straub and SEC v. Steffen.

Today’s post is from Russ Ryan (Partner, King & Spalding). Prior to joining King & Spalding, Ryan spent ten years in the SEC’s Division of Enforcement, including his last three years as Assistant Director of the Division. Ryan, along with his colleagues at King & Spalding (Gary Grindler – former DOJ Acting Deputy Attorney General - and Ehren Halse-Stumberg), recently published this client alert on the cases. Ryan contributes this guest post admitting to some confusion regarding the common thread between Straub and Steffen on the issue of personal jurisdiction.

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Am I the only one puzzled that the courts in both Straub and Steffen considered largely dispositive whether or not the respective defendants participated in the deception of U.S. shareholders by signing false accounting certifications or falsifying financial statements?

The irony of the courts’ focus on misleading financial statements is that in neither case – nor in most other Foreign Corrupt Practices Act cases, for that matter – did the SEC even allege that the relevant company’s financial statements were materially misstated. Likewise, nobody was charged with securities fraud under Securities Exchange Act Section 10(b) and Rule 10b-5, presumably because none of the bribes or falsified records were material to the companies involved, which is typical in an FCPA case. Indeed, neither Magyar nor Siemens was charged even with violating the periodic reporting requirements of Exchange Act section 13(a) and the rules thereunder for Form 10-K and 10-Q filings, which don’t require proof of scienter, but do require proof of materiality.

In short, in neither case did the SEC ever allege that financial statements were materially misstated, much less that U.S. shareholders were misled by them. Of course, mere acknowledgment of this point invites the question of to what extent the fight against foreign bribery has to do with the SEC’s core mission of protecting U.S. investors. Indeed, as Professor Koehler’s article “The Story of the Foreign Corrupt Practices Act” highlights, the SEC did not want any role in enforcing what would become the FCPA’s anti-bribery provisions.

Let’s face it: Most foreign bribery by employees of U.S. issuers and domestic concerns, although perhaps reprehensible, does not materially mislead or harm the shareholders of these companies, nor is it intended to do so. To the contrary, even if misguided and short-sighted, most foreign bribery is intended by the bribing employees to enrich their companies, and by extension their shareholders, by boosting real sales and increasing actual revenue. The primary victims are the company’s competitors and the foreign agency or department whose official was corrupted by the company’s bribe – not shareholders.

It’s true, of course, that if and when a company is caught engaging in bribery, the resulting publicity, investigations, and penalties can hurt the company and its shareholders. But this harm is no different from that which flows from the exposure of any kind of corporate criminal misconduct, little of which falls within the SEC’s jurisdiction.

It’s also true that most foreign bribery involves some evasion of a company’s internal accounting controls and/or some degree of falsification of a company’s books and records, conduct well within the SEC’s core area of interest whenever an issuer is involved. But these transgressions typically occur entirely or substantially at a remote subsidiary of the issuer and, even in the aggregate, rarely come close to being material to the issuer itself.

The SEC’s theory is usually that the remote subsidiary’s books and records “roll up” into the issuer’s, and thus are part of the issuer’s own books and records, so they are fair game. As this prior FCPA Professor post highlighted, the SEC has also argued that payments that violate the FCPA are qualitatively material even if quantitatively immaterial. For present purposes we can stipulate to the reasonableness of these positions.

But it brings us back to the issue of personal jurisdiction over foreign employees of issuers who lack any meaningful connection with the United States other than working for a company that happens to have SEC-registered securities and SEC filing obligations. Whether the foreign employee participates in a bribe or a falsification of books and records outside the United States, it is hard to see how that conduct could ever be viewed as a deliberate effort to mislead U.S. shareholders, much less suffice to subject the employee to personal jurisdiction in a law enforcement case being prosecuted in a U.S. court. And why courts would consider this the lynchpin of their personal jurisdiction analysis is likewise far from clear.

“Far Too Attenuated” – Judge Grants Herbert Steffen’s Motion To Dismiss In SEC FCPA Enforcement Action

Wednesday, February 20th, 2013

Earlier this month Judge Richard Sullivan (S.D.N.Y.Y) denied a motion to dismiss in an SEC FCPA enforcement action against foreign national defendants. (See here for the prior post discussing the decision in SEC v. Straub). Judge Sullivan concluded that “the SEC has met its burden” at the early stages of the case to establish personal jurisdiction over the defendants in that the defendants had sufficient “minimum contacts” with the U.S. such that the exercise of personal jurisdiction over the defendants was “reasonable.” Judge Sullivan only then proceeded to address statute of limitations issues as well as whether the jurisdictional element of an FCPA anti-bribery violation had been properly alleged.

It was noted in the prior post that similar issues were also presented in the SEC’s FCPA enforcement action against former Siemens executive Herbert Steffen, also in the S.D.N.Y.

Yesterday, Judge Shira Scheindlin (a federal court judge well versed in FCPA issues giving her involvement in the Bourke case) granted Steffen’s motion to dismiss the SEC’s complaint. (See here for the opinion and order). Because Judge Schneindlin concluded, as an initial threshold matter, that personal jurisdiction over Steffen exceeded the limits of due process, she did not address Steffen’s other challenges, including as to statute of limitations issues. Unlike the defendants in Straub, Steffen was not alleged to have signed any management representation letters used in connection with financial reporting.

In short, Judge Scheindlin stated as follows.

“If this Court were to hold that Steffen’s support for the bribery scheme satisfied the minimum contacts analysis, even though he neither authorized the bribe, nor directed the cover up, much less played any role in the falsified filings, minimum contacts would be boundless. [...] [U]nder the SEC’s theory, every participant in illegal action taken by a foreign company subject to U.S. securities laws would be subject to the jurisdiction of U.S. courts no matter how attenuated their connection with the falsified financial statements. This would be akin to a tort-like foreseeability requirement, which has long been held to be insufficient.”

The remainder of this post provides context and summarizes Judge Scheindlin’s decision.

As noted in this previous post summarizing the allegations in the SEC’s December 2011 complaint against seven former Siemens executives, the conduct at issue involved a sliver of the overall conduct at issue in Siemens high-profile 2008 FCPA enforcement action. In short, the allegations concerned an alleged bribery scheme in Argentina concerning a national identity card contract and - as to Steffen (the former CEO of Siemens S.A. Argentina who retired in 2003) Judge Scheindlin summarized the allegations as follows.

”The Complaint alleged that [Defendant] Sharef recruited Steffen ‘to facilitate the payment of bribes’ to officials in Argentina because of his longstanding connections in Argentina, which he acquired during his tenure at Siemens Argentina. Following the cancellation of the contract, beginning in December 2000, Steffen and Sharef began renegotiating with the Argentine government, including the newly elected President, which demanded that Siemens paid it bribes in order to reinstate the contract. In order to facilitate payment of bribes to the Argentine officials, Steffen met several times with [Defendant] Regendantz, who become the Chief Financial Officer of [Siemens Business Services - SBS] in February 2002, and ‘pressured’ Regendantz to authorize bribes from SBS to Argentine officials. In April 2002, Steffen told Regendantz that SBS had a ‘moral duty’ to make at least an ‘advance payment’ of ten million dollars to the individuals who had previously handled the bribes because he and other individuals were being threatened as a result of the unpaid bribes. Once Regendantz authorized the bribes, the allegations against Steffen are limited to participation in a phone call initiated by Sharef from the United States in connection with the bribery scheme, and that in the first half of 2003, defendants including Steffen ‘urged Sharef to meet the demands [of Argentine officials] and make the additional payments.”

Judge Scheindlin next addressed whether the SEC’s complaint alleged sufficient facts to establish the two components of the due process – minimum contacts and reasonableness. Judge Scheindlin noted that because the SEC alleged specific jurisdiction over Steffen, this required that he “purposefully directed his activities towards [the U.S.] and the litigation arises out of or is related to [Steffen's ] contact with the forum.

Judge Scheindlin then stated as follows.

“It is well-established that a court may exercise personal jurisdiction over a foreign defendant who causes an effect in the forum by an act committed elsewhere. However, ‘this is a principle that must be applied with caution, particularly in an international context.’ ‘Foreseeability’ alone has never been a sufficient benchmark for personal jurisdiction under the Due Process Clause.’ Rather defendants must have ‘followed a course of conduct directed at … the jurisdiction of a given sovereign, so that the sovereign has the power to subject the defendant to judgment concerning the conduct. The effects in the United States must ‘occur as a direct and foreseeable result of the conduct outside the territory’ and defendant ‘must know,or have good reason to know, that his conduct will have effects in the [forum] seeking to assert jurisdiction over him.”

After noting the legal standards for “reasonableness,” Judge Scheindlin concluded that the court lacked personal jurisdiction over Steffen in that the SEC did not establish minimum contacts and that the exercise of jurisdiction over Steffen was not reasonable.

As to minimum contacts, Judge Scheindlin stated as follows.

“The SEC’s allegations are premised on Steffen’s role in encouraging Regendantz to authorize bribes to Argentine officials that ultimately resulted in falsified filings. While Steffen’s actions may have been a proximate cause of the false filings – and that is a matter of some doubt – Steffen’s actions are far too attenuated from the resulting harm to establish minimum contacts. Steffen was brought into the alleged scheme based solely on his connections with Argentine officials. In furtherance of his negotiations with those officials, Steffen ‘urged’ and ‘pressured’ Regendantz to make certain bribes. However, Regendantz did not agree to make the bribes until he communicated with several ‘higher ups’ whose responses he perceived to be instructions to make the bribes. Once Regendantz agreed to make the bribes – following receipt of instructions from Siemens’ management rather than Steffen – Steffen’s alleged role was tangential at best. Steffen did not actually authorize the bribes. The SEC does not allege that he directed, ordered or even had awareness of the cover ups that occurred at SBS much less that he had any involvement in the falsification of SEC filings in furtherance of those cover ups.”

In a footnote, Judge Scheindlin then stated as follows.

“Neither Sharef’s call to Steffen from the United States nor the fact that a portion of the bribery payments were deposited in a New York bank provide sufficient evidence of conduct directed towards the United States to establish minimum contacts. First, Steffen did not place the calls to Sharef. Further, Steffen did not direct that the funds be routed through a New York bank. [...] His conduct was focused solely on ensuring the continuation of the Siemens contract in Argentina.”

Judge Scheindlin then noted that in SEC v. Straub, the defendants not only orchestrated a bribery scheme aimed at the Macedonia government but also as part of the bribery scheme “signed off on misleading management representations to the company’s auditors and signed false SEC filings.”

Judge Scheindlin next stated as follows.

“If this Court were to hold that Steffen’s support for the bribery scheme satisfied the minimum contacts analysis, even though he neither authorized the bribe, nor directed the cover up, much less played any role in the falsified filings, minimum contacts would be boundless. Illegal corporate action almost always requires cover ups, which to be successful must be reflected in financial statements. Thus, under the SEC’s theory, every participant in illegal action taken by a foreign company subject to U.S. securities laws would be subject to the jurisdiction of U.S. courts no matter how attenuated their connection with the falsified financial statements. This would be akin to a tort-like foreseeability requirement, which has long been held to be insufficient. The allegations against Steffen fall far short of the requirement that he ‘follow a course of conduct directed … the jurisdiction of a given sovereign, so that the sovereign has the power to subject the defendant to judgment concerning that conduct. Absent any alleged role in the cover ups themselves, let alone any role in preparing false financial statements the exercise of jurisdiction here exceeds the limts of due process, as articulated by the Supreme Court and the Second Circuit.”

As to reasonableness, Judge Scheindlin stated as follows.

“The decision not to exercise jurisdiction in this case is bolstered by my conclusion that requiring Steffen to defend this case in the United States would be unreasonable. [...] When a defendant is not located in the United States, ‘great care and reserve should be exercised when extending our notions of personal jurisdiction into the international context. Steffen’s lack of geographic ties to the United States, his age, his poor proficiency in English, and the forum’s diminished interest in adjudicating the matter, all weight against personal jurisdiction. [...] [I]t would be a heavy burden on this seventy-four year old defendant to journey to the United States to defend against this suit. Further, the SEC and the Department of Justice have already obtained comprehensive remedies against Siemens and Germany has resolved an action against Steffen individually. The SEC’s interest in ensuring that this type of conduct does not go unpublished will not be furthered by continuing the suit against Steffen, in light of his age, the burden to defend this suit, and the previous adjudications.”

*****

Steffen was represented by Skadden lawyers Erich Schwartz (here – former Assistant Director of the SEC Enforcement Division) and Amanda Grier (here). In an e-mailed statement, Schwartz stated as follows. “We are extremely pleased with this decision, and in particular that the Court recognized the unreasonableness under the circumstances of forcing Mr. Steffen to answer these charges in the U.S.”

A Focus On World-Wide Coin

Thursday, February 14th, 2013

The SEC’s administrative order (here) in the December 2012 Allianz enforcement action cited SEC v. World-Wide Coin Investments, 567 F.Supp. 724 (N.D. Ga. 1983) for the following proposition. “[The FCPA's books and records provisions do] not require that the amounts involved be “material,” nor is it necessary to prove “scienter” under its provisions. [...] Similarly, there is no scienter requirement for establishing a violation of [the FCPA's internal controls provisions].

These citations are not inaccurate, but nor do they tell the whole story of World-Wide Coin’s holding.

So what does World-Wide Coin really say about the FCPA’s books and records and internal control provisions?

For starters, World-Wide Coin, amazingly given the generic nature of the FCPA books and records and internal controls provisions, appears to be the only judicial decision that directly addresses the substance of these provisions. [If anyone is familiar with another such case, please let me know]. Yes, there are hundreds of cases if you run a search that include passing reference to the FCPA’s books and records and internal control provisions, but the decisions are generally void of substantive analysis.

The pertinent holding of World-Wide Coin, in the words of Judge Robert Vining, is as follows.

“The definition of accounting controls does comprehend reasonable, but not absolute, assurances that the objectives expressed in it will be accomplished by the system. The concept of “reasonable assurances” contained in [internal control provisions] recognizes that the costs of internal controls should not exceed the benefits expected to be derived. It does not appear that either the SEC or Congress, which adopted the SEC’s recommendations, intended that the statute should require that each affected issuer install a fail-safe accounting control system at all costs. It appears that Congress was fully cognizant of the cost-effective considerations which confront companies as they consider the institution of accounting controls and of the subjective elements which may lead reasonable individuals to arrive at different conclusions. Congress has demanded only that judgment be exercised in applying the standard of reasonableness. [...] It is also true that the internal accounting controls provisions contemplate the financial principle of proportionality—what is material to a small company is not necessarily material to a large company.”

That remainder of this post summarizes the facts and holding of World-Wide Coin.

Factually, World-Wide Coin was an egregious case and the FCPA issues addressed were not very difficult for Judge Vining in ruling on the SEC’s request for a permanent injunction. The case involved a wide-ranging securities fraud action involving World-Wide Coin, a business engaged primarily in the wholesale and retail sale of rare coins, precious metals, gold and silver coins, and bullion. Its stock was registered with the SEC and listed on the Boston Stock Exchange. Joseph Hale was the company’s controlling shareholder, chairman of the board, chief executive officer and president and Floyd Seibert was a member of the board and served as the company’s one-man audit committee.

In the words of Judge Vining:

“The deterioration of World-Wide’s internal controls and accounting procedures constituted the primary thrust of the SEC’s complaint. The SEC contended that the combination of late filings, lack of internal controls, transactions unsupported by adequate documentation, and a total disregard for proper accounting procedures resulted in the precarious position of the company. [...] The company’s accounting books were virtually ignored. General ledgers and general journals were not kept, and the checks written on World-Wide’s five checking accounts were not reconciled.”

Judge Vining described a bookkeeper hired by the company as follows. “[She] was not a high school graduate; her only experience for this position consisted of five months of vocational school training and seven years of bookkeeping for a privately held lumber company.”

Judge Vinings findings of fact also highlights how the accounting firm Kanes, Benator & Co., retained by the company as an independent auditor, wrote a letter to the company “expressing grave concern over certain accounting procedures and lack of internal controls that [it] considered to be detrimental to the company. […] This letter [notified] World-Wide of its deficiencies in its internal accounting controls …” Yet, “even with this official notice that improvements were needed, Hale and Seibert did nothing to remedy the situation, and the criticisms of [it] were virtually ignored.”

With respect to a 10K report, the individuals “prepared it themselves without the assistance of counsel and it contained” numerous misrepresentations. “The company’s problems increased […] mostly resulting from its chaotic bookkeeping practices and total disregard for an adequate internal control system.” The decision goes into great detail concerning the “problems that occurred at the company with respect to internal controls and accounting procedures” such as “(1) inventory problems, (2) problems with separation of duties and the lack of documentation of transactions, and (3) problems with the books, records, and accounting procedures of the company.”

As to the defendants’ position, the decision states as follows.

“With respect to the SEC’s allegations of violations of the [FCPA], the defendants presented a cost/benefit argument, contending that a company the size of World-Wide should not be subjected to overly burdensome internal controls systems requirements, and accounting procedures, since compliance with such requirements would, as a practical matter, put small companies such as World-Wide out of business.”

Judge Vining called the FCPA’s provisions on accounting controls “short and deceptively straight-forward.” He stated as follows.

“The only express congressional requirement for accuracy is the phrase ‘in reasonable detail.’ Although [the books and records provisions] expects management to see that the corporation’s recordkeeping system is adequate and effectively implemented, how the issuer goes about this task is up to management; the FCPA provides no guidance, and this court cannot issue any kind of advisory opinion. Just as the degree of error is not relevant to an issuer’s responsibility for any inaccuracies, the motivations of those who erred are not relevant. There are no words in [the books and record provisions] indicating that Congress intended to impose a scienter requirement …”.

Judge Vining continued as follows.

“Like the recordkeeping provisions of the Act, the internal controls provision is not limited to material transactions or to those above a specific dollar amount. While this requirement is supportive of accuracy and reliability in the auditor’s review and financial disclosure process, this provision should not be analyzed solely from that point of view. The internal controls requirement is primarily designed to give statutory content to an aspect of management stewardship responsibility, that of providing shareholders with reasonable assurances that the business is adequately controlled.”

“Internal accounting control is, generally speaking, only one aspect of a company’s total control system; in order to maintain accountability for the disposition of its assets, a business must attempt to make it difficult for its assets to be misappropriated. The internal accounting controls element of a company’s control system is that which is specifically designed to provide reasonable, cost-effective safeguards against the unauthorized use or disposition of company assets and reasonable assurances that financial records and accounts are sufficiently reliable for purposes of external reporting. [...] Internal accounting controls must be distinguished from the accounting system typically found in a company. Accounting systems process transactions and recognize, calculate, classify, post, summarize, and report transactions. Internal controls safeguard assets and assure the reliability of financial records, one of their main jobs being to prevent and detect errors and irregularities that arise in the accounting systems of the company. Internal accounting controls are basic indicators of the reliability of the financial statements and the accounting system and records from which financial statements are prepared.”

Among the factors that determine the internal accounting control environment of a company are its organizational structure, including the competence of personnel, the degree and manner of delegation and responsibility, the quality of internal budgets and financial reports, and the checks and balances that separate incompatible activities. The efficiency of the internal control system of a company cannot be evaluated without considering the company’s organizational structure, the caliber of its employees, the strength of its audit committee, the effectiveness of its internal audit operation, and a host of other factors which, while not part of the internal control system itself, have an impact on the function of the system.”

“Although not specifically delineated in the Act itself, the following directives can be inferred from the internal controls provisions: (1) Every company should have reliable personnel, which may require that some be bonded, and all should be supervised. (2) Account functions should be segregated and procedures designed to prevent errors or irregularities. The major functions of recordkeeping, custodianship, authorization, and operation should be performed by different people to avoid the temptation for abuse of these incompatible functions. (3) Reasonable assurances should be maintained that transactions are executed as authorized. (4) Transactions should be properly recorded in the firm’s accounting records to facilitate control, which would also require standardized procedures for making accounting entries. Exceptional entries should be investigated regularly. (5) Access to assets of the company should be limited to authorized personnel. (6) At reasonable intervals, there should be a comparison of the accounting records with the actual inventory of assets, which would usually involve the physical taking of inventory, the counting of cash, and the reconciliation of accounting records with the actual physical assets. Frequency of these comparisons will usually depend on the cost of the process and upon the materiality of the assets involved.”

Judge Vining then stated as follows.

“The main problem with the internal accounting controls provision of the FCPA is that there are no specific standards by which to evaluate the sufficiency of controls; any evaluation is inevitably a highly subjective process in which knowledgable individuals can arrive at totally different conclusions. Any ruling by a court with respect to the applicability of both the accounting provisions and the internal accounting control provisions should be strictly limited to the facts of each case.”

Judge Vining then summarized the defendants’ arguments as follows.

“The defendants in the instant case contend that the SEC has misconstrued the provisions of the FCPA relating to a knowledge requirement, contending that the SEC must show scienter. The defendants further state that the SEC does not allege a knowing attempt to circumvent for an improper purpose an internal control system required by law and that the complaint ignores all considerations of the costs and benefits of internal accounting controls and seeks to require World-Wide to maintain a system of controls that would destroy the company.”

Judge Vining then stated as follows.

“The definition of accounting controls does comprehend reasonable, but not absolute, assurances that the objectives expressed in it will be accomplished by the system. The concept of “reasonable assurances” contained in section 13(b)(2)(B) recognizes that the costs of internal controls should not exceed the benefits expected to be derived. It does not appear that either the SEC or Congress, which adopted the SEC’s recommendations, intended that the statute should require that each affected issuer install a fail-safe accounting control system at all costs. It appears that Congress was fully cognizant of the cost-effective considerations which confront companies as they consider the institution of accounting controls and of the subjective elements which may lead reasonable individuals to arrive at different conclusions. Congress has demanded only that judgment be exercised in applying the standard of reasonableness. The size of the business, diversity of operations, degree of centralization of financial and operating management, amount of contact by top management with day-to-day operations, and numerous other circumstances are factors which management must consider in establishing and maintaining an internal accounting controls system. However, an issuer would probably not be successful in arguing a cost-benefit defense in circumstances where the management, despite warnings by its auditors or significant weaknesses of its accounting control system, had decided, after a cost benefit analysis, not to strengthen them, and then the internal accounting controls proved to be so inadequate that the company was virtually destroyed. It is also true that the internal accounting controls provisions contemplate the financial principle or proportionality—what is material to a small company is not necessarily material to a large company.”

Judge Vining concluded his decision as follows.

“This court has already declined to adopt the defense offered by the defendants that the accounting controls provisions of the FCPA require a scienter requirement. The remainder of World-Wide’s defense appears to be that such a small operation should not be required to maintain an elaborate and sophisticated internal control system, since the costs of implementing and maintaining it would financially destroy the company. It is true that a cost/benefit analysis is particularly relevant here, but it remains undisputed that it was the lack of any control over the inventory and inadequate accounting procedures that primarily contributed to World-Wide’s demise. No organization, no matter how small, should ignore the provisions of the FCPA completely, as World-Wide did. Furthermore, common sense dictates the need for such internal controls and procedures in a business with an inventory as liquid as coins, medals, and bullion.”

“The evidence in this case reveals that World-Wide, aided and abetted by Hale and Seibert, violated the provisions of section 13(b)(2)(B) of the FCPA. As set forth in the factual background portion of this order, the internal recordkeeping and accounting controls of World-Wide has been sheer chaos since Hale took over control of the company. For example, there has been no procedure implemented with respect to writing checks: employees have had access to presigned checks; source documents were not required to be prepared when a check was drawn; employees have not been required to obtain approval before writing a check; and, even when a check was drawn to cash, supporting documentation was usually not prepared to explain the purpose for which the check was drawn. In addition to extremely lax security measures such as leaving the vault unguarded, there has been no separation of duties in the areas of purchase and sales transactions, and valuation procedures for ending inventory. Furthermore, no promissory notes or other supporting documentation has been prepared to evidence purported loans to World-Wide by Hale or by his affiliate companies.”

“Since Hale obtained control of World-Wide, employees have not been required to write source documents relating to the purchase and sale of coins, bullion, or other inventory. Because of this total lack of an audit trail with respect to these transactions and the disposition of World-Wide’s assets, it has been virtually impossible to determine if an item has been sold at a profit or at a loss. Furthermore, there are more than $1,700,000 worth of checks drawn to Hale or to Hale’s affiliates, or to cash, for which no adequate source documentation exists. Furthermore, Hale and Seibert knew that the medallions that were sold to World-Wide by Hale in 1979 were overvalued and unmarketable. Even so, they allowed the incorrect value of the medallions to be entered on the books of World-Wide. They also knew that the company’s books and records were neither accurate nor complete. Pursuant to their directives, source documents were not prepared with respect to the transfer of funds; additionally, no audit trail was maintained for the acquisition and disposition of inventory. Furthermore, it appears that there were numerous false and misleading statements and omissions in the company’s numerous reports to the SEC, many of which were filed late or not at all.”

“Individually, the acts of these defendants do not appear so egregious as to warrant the full panoply of relief requested by the SEC nor to impose complete liability under the FCPA. However, the court cannot ignore the all-pervasive effect of the combined failure to act, failure to keep accurate records, failure to maintain any type of inventory control, material omissions and misrepresentations, and other activities which caused World-Wide to decrease from a company of 40 employees and assets over $2,000,000 to a company of only three employees and assets of less than $500,000. It is evident that World-Wide, Hale, and Seibert violated all provisions contained in section 13(b)(2)(A) and (B) and the SEC’s rules promulgated thereunder.”

The FCPA As An Ambiguous Statute And The Importance Of Legislative History

Wednesday, February 13th, 2013

Several FCPA commentators object to the notion that the Foreign Corrupt Practices Act is ambiguous.

Writing recently at Forbes (see here for the article titled “Top 5 Misconceptions About The FCPA”), Howard Sklar set out to “clear up a few misconceptions about the FCPA.” Number one on his list of misconceptions was that ‘the FCPA is a vague statute.” Writing on his FCPA Blog, Richard Cassin has long maintained (see here and here for the more recent iteration) that FCPA lawyers say that the law is “complicated, technically challenging, obscure, poorly drafted and badly organized.” Cassin however warned as follows. “But don’t believe it. There’s no evidence in the record that judges or juries have any trouble understanding the FCPA.”

The above protestations and observations are just plain wrong. There is abundant ”evidence in the record” that the FCPA is an ambiguous statute. Don’t take my word, read FCPA case law

In fact, last week Judge Richard Sullivan (S.D.N.Y.) concluded what several other federal court judges before him have previously concluded – that the FCPA is an ambiguous statute. (See here for the prior post discussing Judge Sullivan’s opinion in SEC v. Straub, including his conclusion that the jurisdictional element of an FCPA anti-bribery violation is ambiguous).

This post summarizes the many instances in which federal court judges have found various provisions of the FCPA to be ambiguous.

In U.S. v. Kay, 200 F.Supp.2d 681 (S.D. Tex. 2002), Judge David Hittner concluded that the FCPA’s “obtain or retain business” element was ambiguous and he thus turned to an analysis of the legislative history. On appeal, the Fifth Circuit (see 359 F.3d 738 (5th Cir. 2004)) likewise stated as follows prior to an extensive review of the FCPA’s legislative history.

“[T]he district court concluded that the FCPA’s language is ambiguous, and proceeded to review the statute’s legislative history. We agree with the court’s finding of ambiguity for several reasons. Perhaps our most significant statutory construction problem results from the failure of the language of the FCPA to give a clear indication of the exact scope of the business nexus element; that is, the proximity of the required nexus between, on the one hand, the anticipated results of the foreign official’s bargained-for action or inaction, and, on the other hand, the assistance provided by or expected from those results in helping the briber to obtain or retain business. Stated differently, how attenuated can the linkage be between the effects of that which is sought from the foreign official in consideration of a bribe (here, tax minimization) and the briber’s goal of finding assistance or obtaining or retaining foreign business with or for some person, and still satisfy the business nexus element of the FCPA?”

In Stichting v. Schreiber, 327 F.3d 173 (2d Cir. 2003), the Court stated as follows. “It is difficult to determine the meaning of the word “corruptly” simply by reading it in context. We therefore look outside the text of the statute to determine its intended meaning. [...] (“Legislative history and other tools of interpretation may be relied upon only if the terms of the statute are ambiguous.”

In U.S. v. Bodmer, 342 F.Supp.2d 176 (S.D.N.Y. 2004), Judge Shira Scheindlin addressed the question “whether prior to the 1998 amendments, foreign nationals who acted as agents of domestic concerns, and who were not residents of the United States, could be criminally prosecuted under the FCPA.” Judge Scheindlin concluded that the FCPA’s language, as it existed prior to the 1998 amendments, was ambiguous and she thus resorted to legislative history. Judge Scheindlin further commented in dismissing the FCPA charges against Bodmer as follows. “After consideration of the statutory language, legislative history, and judicial interpretations of the FCPA, the jurisdictional scope of the statute’s criminal penalties is still unclear.”

In U.S. v. Kozeny, 493 F.Supp.2d 693 (S.D.N.Y. 2007), Judge Scheindlin stated as follows concerning the statute of limitations applicable to FCPA criminal violations. “I find that [18 U.S.C. § 3282] is ambiguous, and turn to its legislative history for guidance on its proper interpretation.”

In U.S. v. Jensen, 532 F.Supp.2d 1187 (N.D. Cal. 2008), Judge Charles Breyer stated as follows regarding § 78m(b)(5) which makes “knowing” violations of the FCPA books and records and internal control provisions a crime. “Because the plain language of § 78m(b)(5) is not unambiguous, the Court turns to legislative history.”

In all of the above examples, given the ambiguity in the FCPA, courts resorted to legislative history to construe the statute. This is why the FCPA’s legislative history remains vital and important. (See here for my article “The Story of the Foreign Corrupt Practices Act” and here for my “foreign official” declaration detailing the FCPA’s legislative history relevant to this element).

In addition to the above examples, FCPA legislative history was also consulted in construing statutory terms in the following cases.

SEC v. Jackson (S.D.N.Y. – Dec. 2012) (Judge Keith Ellison consulting legislative history regarding: the need to identify the “foreign official,” the facilitation payments exception, and the corrupt intent element).

U.S. v. Kozeny, 582 F.Supp.2d 535 (S.D.N.Y. 2008), Judge Scheindlin consulting legislative history regarding the local law affirmative defense.

The above referenced Forbes article began as follows. “Bad information is often worse than no information. There is a tremendous amount of noise in the discussion around FCPA. Not only noise, but anti-signal. That is, not just bad information, but information that is contrary to fact.”

Spot-on.